The Bank of England Blasts The Threat To Capital Markets That Is High Frequency Trading

Tyler Durden's picture

Zero Hedge has been warnings about the scourge of High Frequency Trading long before most in the general public had even heard about the concept. Over the past 2 years, and culminating with the Flash Crash it became all too clear that HFT is nothing but a parasitic phenomenon which churns volume in stocks providing the best liquidity rebates, while pretending to be adding liquidity. Recently the best we can do is to provide glaring examples of HFT algos gone wrong in hopes that some regulator somewhere will finally take the long overdue step to establish a minimum bid/ask time delay and thus put virtually the entire HFT frontrunning math Ph.D. crew out of business. The latest development in the ongoing saga against these parasites comes from none other than the Bank of England's Andrew Haldane who prepared a speech to the International Economic Association Sixteenth World Congress in Beijing China, titled "The race to zero" which essentially recaps the hundreds if not thousands of posts we have written on the matter of risks posed by High Frequency Trading, and blasts the concept, as well as the toothless captured regulators who continue to exist in their zombie, porn-addicted state, and refuse to move one finger to finally end this next Flash Crash-in-waiting.

Some of the key excerpts:

The Flash Crash left market participants, regulators and academics agog. More than one year on, they remain agog. There has been no shortage of potential explanations. These are as varied as they are many: from fat fingers to fat tails; from block trades to blocked lines; from high-speed traders to low-level abuse. From this mixed bag, only one clear explanation emerges: that there is no clear explanation. To a first approximation, we remain unsure quite what caused the Flash Crash or whether it could recur.

That conclusion sits uneasily on the shoulders. Asset markets rely on accurate pricing of risk. And financial regulation relies on an accurate reading of markets. Whether trading assets or regulating exchanges, ignorance is rarely bliss. It is this uncertainty, rather than the Flash Crash itself, which makes this an issue of potential systemic importance.

In many respects, this uncertainty should come as no surprise. Driven by a potent cocktail of technology and regulation, trading in financial markets has evolved dramatically during the course of this century. Platforms for trading equities have proliferated and fragmented. And the speed limit for trading has gone through the roof. Technologists now believe the sky is the limit.

This rapidly-changing topology of trading raises some big questions for risk management. There are good reasons, theoretically and empirically, to believe that while this evolution in trading may have brought benefits such as a reduction in transaction costs, it may also have increased abnormalities in the distribution of risk and return in the financial system. Such abnormalities hallmarked the Flash Crash. This paper considers some of the evidence on these abnormalities and their impact on systemic risk.

His observations on broken market topology: another much discussed topic on ZH:

A diverse and distributed patchwork of exchanges and multilateral trading platforms has emerged in its place. These offer investors a range of execution characteristics, such as speed, cost and transparency, typically electronically. Equity market trading structures have fragmented. This has gone furthest in the US, where trading is now split across more than half a dozen exchanges, multilateral trading platforms and “dark pools” of anonymous trading (Charts 3 and 4). Having accounted for around 80% of trading volume in NYSE-listed securities in 2005, the trading share of the NYSE had fallen to around 24% by February 2011.

The average speed of order execution on the US NYSE has fallen from around 20 seconds a decade ago to around one second today. These days, the lexicon of financial markets is dominated by talk of High-Frequency Trading (HFT). It is not just talk. As recently as 2005, HFT accounted for less than a fifth of US equity market turnover by volume. Today, it accounts for between two-thirds and three-quarters.

The picture is similar, if less dramatic, in Europe. Since 2005, HFT has risen from a tiny share to represent over 35% of the equity market. In Asia and in emerging markets, it is growing fast from a lower base. What is true across countries is also true across markets. HFT is assuming an ever-increasing role in debt and foreign exchange markets. In some futures markets, it already accounts for almost half of turnover. In the space of a few years, HFT has risen from relative obscurity to absolute hegemony, at least in some markets.

On why HFT is nothing but a parasite to capital markets:

Taken together, this evidence suggests something important. Far from solving the liquidity problem in situations of stress, HFT firms appear to have added to it. And far from mitigating market stress, HFT appears to have amplified it. HFT liquidity, evident in sharply lower peacetime bid-ask spreads, may be illusory. In wartime, it disappears. This disappearing act, and the resulting liquidity void, is widely believed to have amplified the price discontinuities evident during the Flash Crash.13 HFT liquidity proved fickle under stress, as flood turned to drought.

Capital markets are now broken beyond a shadow of a doubt, first presented by Zero Hedge several months ago:

Recent studies point, however, to a changing pattern. Non-normal patterns in prices have begun to appear at much higher frequencies. A recent study by Smith (2010) suggests that, since around 2005, stock price returns have begun to exhibit fat-tailed persistence at 15 minute intervals. Given the timing, these non-normalities are attributed to the role of HFT in financial markets.

The measure of stock price abnormality used by Smith is the so-called “Hurst” coefficient. The Hurst coefficient is named after English civil engineer H E Hurst. It was constructed by plotting data on the irregular flooding patterns of the Nile delta over the period 622-1469 AD. Hurst found that flooding exhibited a persistent pattern. Large floods were not only frequent, but came in clumps. They had a long memory.

The Hurst coefficient summarises this behaviour in a single number. For example, a measured Hurst equal to 0.5 is consistent with the random walk model familiar from efficient markets theory. A Hurst coefficient above 0.5 implies fatter tails and longer memories. In his study, Smith finds that the Hurst coefficient among a selection of stocks has risen steadily above 0.5 since 2005. In other words, the advent of HFT has seen price dynamics mirror the fat-tailed persistence of the Nile flood plains.

Also discussed on Zero Hedge: self-similarity in HFT trading, leading to micromomentum bursts that have nothing to do with price discovery and everything to do with Chaos Theory:

To illustrate, Chart 11 plots the path of three simulated price series with Hurst coefficients of 0.5, 0.7 and 0.9. A higher Hurst coefficient radically alters the probability of sharp dislocations in prices. It also prolongs these dislocations. Prices become de-anchored and drift; their variance grows over time and is unbounded. If this long-memory property of prices is emerging at ever-higher frequencies, it might provide an important clue to how HFT affects systemic risk.

To see that, consider a sketch model of market-making. This builds on an analytical insight which is already more than 40 years old. It owes to the late Benoit Mandelbrot, French-American mathematician and between two measuring rods: clock time and volume time. While empirical studies typically used the first measuring rod (days, hours, seconds, milli-seconds), stock prices were better understood by using the second.

Mandelbrot’s explanation was relatively simple. If trading cannot occur within a given time window, price movements can only reflect random pieces of news – economic, financial, political. So, consistent with efficient market theory, price changes would be drawn from a normal distribution with a fat middle and thin tails when measured in clock time. They were a random walk.

But as soon as trading is possible within a period, this game changes. Strategic, interactive behaviour among participants enters the equation. Volumes come and go. Traders enter and exit. Algorithms die or adapt. Behaviour within that time interval may then no longer be random noise. Rather trading  volumes will exhibit persistence and fat tails. This will then be mirrored in prices. So when measured in clock time, prices changes will have thinner middles and fatter tails, just like a cauliflower, a coastline, or a cosmos.

Subsequent studies have shown that this clock time / volume time distinction helps explain equity price dynamics, especially at times of market stress. For example, Easley et al (2011) show that the distribution of price changes during the Flash Crash was highly non-normal in clock time, with fat tails and persistence. But in volume time, normal service – indeed, near-normality – resumed. This fractal lens can be used to explain why market liquidity can evaporate in situations of market stress, amplifying small events across time, assets and markets. Fractal geometry tells us that what might start off as a snowflake has the potential to snowball.

His observation on captured regulation:

Regulation has thin-sliced trading. And technology has thin-sliced time. Among traders, as among stocks on 6 May, there is a race to zero. Yet it is unclear that this race will have a winner. If it raises systemic risk, it is possible capital markets could be the loser. To avoid that, a redesign of mechanisms for securing capital market stability may be needed.

And the conclusion:

The Flash Crash was a near miss. It taught us something important, if uncomfortable, about our state of knowledge of modern financial markets. Not just that it was imperfect, but that these imperfections may magnify, sending systemic shockwaves. Technology allows us to thin-slice time. But thinner  technological slices may make for fatter market tails. Flash Crashes, like car crashes, may be more severe the greater the velocity.

Physical catastrophes alert us to the costs of ignoring these events, of normalising deviance. There is nothing normal about recent deviations in financial markets. The race to zero may have contributed to those abnormalities, adding liquidity during a monsoon and absorbing it during a drought. This fattens tail risk. Understanding and correcting those tail events is a systemic issue. It may call for new rules of the road for trading. Grit in the wheels, like grit on the roads, could help forestall the next crash.

Alas, nothing will happen. Until the next crash, when everyone will say nobody could have seen this happen. Nobody.

Much more in the full presentation, including many pretty charts (link)


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SparkySC's picture

How about another Flash Crash today?

Teach them all a valuable lesson. It has to happen again, so they get rid of these Algo programs forever.

Mr Lennon Hendrix's picture

Algo Machines from Hell are the only performing assets on the Street, and you want to get rid of them?  Without the Algo Machines from Hell and without their Flash Crashes, GDP would be negative, and you want to get rid of them?

Ahmeexnal's picture

The concept humans have of time is flawed.

SMG's picture

That Bix Weir guy of the Road to Roota theory, has said the "good guys" were going to crash the market and blame it on HFT's.

He hasn't been 100% though.   I don't even know if there are any "good guys" left.   God, I hope so.

Mr Lennon Hendrix's picture

The Bank of England should have no say in any matter what so ever, because they started this whole fiat ponzi.  The BoE should be burned to the ground along with its proxie bank, the Federal Reserve.

TruthInSunshine's picture

Under a gold standard, the amount of credit that an economy can support is determined by the economy's tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government's promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which — through a complex series of steps — the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.


-- Alan Greenspan


Alan Greenspan, Gold and Economic Freedom (1966)
Pseudo Anonym's picture

The Bank of England should have no say in any matter what so ever, because they started this whole fiat ponzi.

who's "they"?  The BOE is an inanimate institution.  It's the hofjuden running that joint that must be smoked out and burnt in a gas chamber.

Zero Govt's picture

i 2nd the vote to burn the BoE to the ground... if the fire takes hold of Westminster too it's 'Bonus Time'

Mr Lennon Hendrix's picture

The BoE is a corporate institution that has wrecked the wealth of the State, and because society had established the State, the wealth of the people has been stolen from it.  This whole depression has been orchestrated by the corporations (BoE/Fed) so to inherit the economic landscape.  The BoE is directly responsible.

They did so by issuing currencie, but then taking the currencie off of the standard of real monie (gold/silver) and instituting the fiat ponzi.  Then they used the fiat ponzi to tax people unconstitutionally and used the stolen proceeds to give to other corporations (JPM, CAT, GM, etc) after they crashed markets by keeping interest rates low and ushering in the Housing Crash.

Now, once again, they offer solutions to the problems; the problems that they created.

Bartanist's picture

Where would volume be without HFT?

They would have to elimate the ETFs and other bucket shop bets to concentrate liquidity back in real equities. How many "so called" bankers would lose their jobs over that move? (answer: probably not enough)

SilverIsKing's picture

Dodd-Frank didn't address this?  Gee, wonder why...

Hondo's picture

They need to ban it in the UK and true trading for "investment" will migrate to the UK and leave the US market to the casino players for a slow or not so slow death.

doomandbloom's picture

People have forgotten to produce...there is no remedy for that

The services industry relied on middlemen ( banks etc) , who intially helped to provide information, enable people to get capital etc..but who were corrupt and grew too big. They did however give a lot of jobs..meaningless jobs...which kept people happy.

Internet is changing the game, the middlemen no longer have the power..but people have forgotten to produce, to create...

Many people think making money is the end the era of the middlemen and information assymetry

So these traders who think they know how to trade...have lost their edge...its the computer engineers that are making the money....this is the end of trading as we know it..

Jovil's picture

The bankers almost always win in the end and f**k the people. When they get into trouble the people bail them out. Is is rigged that way.

Just look at how the system is setup. One picture is worth a thousand words.


sbenard's picture

That pic looks more like a kleptocracy than capitalism to me. That's how they should have labeled it IMHO.

alien-IQ's picture

i've become quite fond of the term "Strumpetocracy"...I think it's more fitting and encompassing:-)

sbenard's picture

Ooh, I wonder if George "Spooky Dude" Soros will tremble in his slippers. He has broken the Bank of England before, so I doubt it!

Smiddywesson's picture

Every market blowout need a villain, and the real villains are not going to take the fall.

HFTs have been doing this for a long time, and the Bank of England knew it, but now, when the jig is up, they come out railing against HFT trading.

Bingo!  Gentlemen, we have a scapegoat.  The recovery was shortsheeted by the evil speculators known as HFT quants.  That explains everything. 

Expect a few of the smaller thieves to be hung by the bigger thieves before all is said and done.

Cdad's picture

Just as regulators should be looking into the threat of HFTs, so should they be evaluating the flawed mechanism known as the ETF.  The difficulty, in both cases, is finding regulators that are not corrupt or bought, as well as finding regulators smart enough to understand the two issues.

I defy any regulator within the sound of my comments to follow the math associated with creation units.  It is my opinion that the the systemic risks of ETF construction is every bit as threatening as the HFT.

But again, if the flood of pink slips in the financial services sector could just get going, we would be well on our way to addressing the primary problem of this parasitic, unproductive class.

Hacksaw's picture

I agree totally. ETFs are derivatives of mass destruction with as much destructive power as CDSs. Every ETF should have a warning label, woe to all who enter here.

alien-IQ's picture

wait a minute...are you saying that it WAS"NT Waddell & Reed that caused the flash crash?

But..but..but..the SEC said...

Tense INDIAN's picture

this is ONLY GOOD gold mining stock in Indian market ....sadly it ended the BULL when the bull in Gold started.....has been declining for a long time ...most probably it will also lead the next GOLD BULL by a couple of months.....:::



I_ate_the_crow's picture

Great opening paragraph. Parasites indeed.

espirit's picture

"Algo's Gone Wrong".  If this was a new un-reality show during primetime TV, I'd watch it.

rufusbird's picture

Great topic, good post, good comments!

Mercury's picture


I've certainly put in my two cents on this issue in posts past.

It would be nice if this issue finally gained some traction.

Urban Redneck's picture

This could be fixed in one day with a one-page bill and a banker tax that is actually SUPPORTED by significant number of jet owning top .001% BANKERS. That the TBTF management oppose it, and that the transaction tax will never become law- even with an ass clown-in-chief desparate to save his job and blame someone else for the bad economy, and 535 congress-clowns desparate for tax revenue aka debt-free pork, should serve as a warning as to just how influential the TBTF subset of the industry has become.

bonddude's picture

When the aliens (my mom) get here I vote Tyler be our representative. we need galactic 

truth tellers. mmmK?

Catullus's picture

This is central bankers realizing they've lost control of the markets. That's all central banking was ever about. HFT is a threat to the system itself. It can literally imagineer M3. The central banking cartel has to be aware of this.

binky's picture

The move from fractions to decimals has been a huge success.

Waterfallsparkles's picture

Hft holds the Market up. Plus, the Weekly options.

I do not think that they will ever get rid of it.  Even though no one trades the Market goes higher and higher.  It appears that HFT can only Buy Stocks.

Funny how every one was against Naked Short selling and now we have a system called HFT that can only Buy Stocks.  No matter how high they go and defy all logic.

I suppose the real problem is that when there are too many sellers HFT shuts down and stocks plunge beyond reason.  Have to remember that the order book is only 3 prices deep.

Waterfallsparkles's picture

Do not need any QE3 just HFT.  That is the slogan.

GoinFawr's picture

So May 6 2010 wasn't simply a 'shot across the bow' designed to water down the Financial Reform Bill?

Hacksaw's picture

Transaction tax now !

Use of Weapons's picture

I find it interesting that Tyler imagines he's not being read in the square mile... Admittedly, a lot of people think that this is the hang-out of the batshit insane or Zynisch-zum-Tode, and there's the 'get your jollies here' crew.


But, bottom line: ZH is read, and often says the 'unspoken'. Just 'cause policy dictates that a policy is enacted doesn't mean the people doing it don't have 'off the record' views.

AldousHuxley's picture

UK is toast. take your depressing island and shove it up your queen's

dcb's picture

while the establishment is always behind the curve, haldane is one of the best out there. How many people in authority are actually speaking out against hft. any in our federal reserve (LOL). his papaer the doom loop, while evident to ZH readers is a classic and should be read by all. I keep it on my computer and send it out to friends.


the other important fact, is that the establishment only listens to people in the club. to get into the club you usually have to have a set world view. that way they always reinforce their ideology. Haldane is one of the few who actually investigates the faults of this world view. Without people like haldane the elites wouldn't even be discussing the topic.

cityguyusa's picture

A shift back to yearly or even 5 year guidance would be nice too.  That would eliminate a lot of speculating and price runups.  Imagine a market that truly worked on fundamentals of a corporations business.

AustrianEconomist's picture

It is clear that the Economic
theories in place are outdated, just look at the unemployment report, 99.99% of
professional economist were completely wrong and are all wearing their rose coloured
glasses rather be realistic. The US economy is in huge trouble, that’s a fact.

Check out the latest from the Capital Research Institute (CRI): Creative Destruction – A New Economic Order

Stares straight ahead's picture


Can you create a calender of these events?